Australian Dollar steadies as Middle East diplomacy takes focus

• AUD/USD trims earlier losses as fresh US-Iran diplomatic signals weigh on the US Dollar.
• Expectations of further Fed tightening continue to offer some support to the US Dollar.
• A hawkish RBA outlook keeps the Aussie supported ahead of next week’s policy meeting.

AUD/USD trims part of its earlier losses on Tuesday as traders assess fresh diplomatic signals surrounding the war between the United States (US) and Iran, weighing on the US Dollar (USD). Meanwhile, a hawkish Reserve Bank of Australia (RBA) outlook continues to provide a firm floor under the Australian Dollar (AUD). At the time of writing, AUD/USD trades around 0.7107, down 0.15% on the day after touching an intraday low of 0.7092.

Iran has offered to reopen the Strait of Hormuz within seven days if the US lifts its blockade of Iranian ports and eases military pressure, according to a senior Iranian official cited by Kyodo News. Markets are also watching the UN General Assembly in New York. US President Donald Trump and Iranian President Masoud Pezeshkian are both attending. Washington says no direct meeting is scheduled so far, while Trump is due to meet several Gulf leaders later on Tuesday.

The development weighs on the US Dollar while also pushing Oil prices lower. The US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, trades around 100.45 after retreating from an intraday high of 100.67, its highest level since July 30. Meanwhile, West Texas Intermediate (WTI) Oil trades near $89.50 and is down more than 5% so far this week.

The downside in the US Dollar, however, remains cushioned by expectations of additional Federal Reserve (Fed) rate hikes. The US central bank raised rates by 25 basis points last week to 3.75%-4.00% and signalled that further tightening may be needed to bring inflation back toward its 2% target. Fed Chairman Kevin Warsh said after the meeting that he would be “hard-pressed to describe broad financial conditions as restrictive.”

On the US economic data front, the latest ADP NER Pulse showed private employers added an average of 20,000 jobs per week over the four weeks ending September 5, up from 16,750 previously

Meanwhile, the Australian Dollar continues to draw support from a hawkish RBA outlook. The central bank has raised rates three times this year, lifting the cash rate to 4.35%, while core inflation remains above its 2%-3% target range.

RBA Governor Michele Bullock said on Tuesday that “upside inflation risks may be materialising,” while stressing that she was “not indicating any policy shift” and that the decision remains with the board. Bullock also said the Australian Dollar “mirrors commodities and interest rate gaps,” adding that neutral rates are rising globally and pushing real bond yields higher.

Markets are pricing in around a 95% chance of another 25-basis-point rate hike to 4.60% at the September 29 meeting. If the RBA raises rates again next week, the wider interest-rate gap with the US could provide additional support to the Aussie.